Avoiding the Traps in the Tax Forms - making filling out tax returns easier

Kiplinger's Personal Finance Magazine, March, 1999 by Marc L. Schulhof

Changes in the paperwork will cost you time, but don't let them cost you money.

By now, you should have all you need (except, perhaps, the will) to complete your 1998 tax forms--the missives from the IRS and mortgage companies and mutual funds and brokers and banks and so on. Be aware that you'll need extra time this year thanks to changes in the tax law--and the tax forms. The standard 1040 form still fits on a single sheet of paper, front and back, but the instructions now include 13 worksheets. Then there are the myriad supplementary forms, complete with their own worksheets and computations, some of which you may need to slog through to come up with the figures to enter on your 1040.

You can still use last year's return as a guide, but don't just blindly follow the path you blazed last spring. New traps along the way could do you in.

One such hazard, according to Martin Nissenbaum, national director of personal income-tax planning at Ernst & Young in New York City, is a "stealth change" in Schedule B, where you report mutual fund dividends. It really comes down to what the IRS's definition of dividends is.

In the past, you had to report gross dividends--an amount that included ordinary dividends plus capital-gains and nontaxable distributions--and then subtract the distributions to arrive at the amount of taxable ordinary dividends.

Starting this year, that rigmarole is gone. You simply report the ordinary dividends shown in box 1 of the 1099-DIV form you get from your fund. (The capital-gains distributions reported in box 2a of the form go directly to your Schedule D.)

Check your 1099s for a figure in box 6--foreign tax paid--and remember that you can probably claim a foreign-tax credit without the hassle of filing the notoriously complex Form 1116. You qualify if all the foreign tax you paid was on investment income and the total was $300 or less on a single return or $600 or less on a joint return. (The tax your fund paid for you out of your earnings--and reports on the 1099--cuts your tax bill dollar for dollar.)

Congress hoped to simplify capital-gains reporting by eliminating the 18-month, midterm holding period. Once again, there is a single, 12-month line of demarcation between short- and long-term gains. But Schedule D still looks like complexity incarnate, says John Mueller, a tax analyst at CCH, a tax publisher in Riverwoods, Ill. Although the midterm-gains category is gone, the 28% rate that applied to it isn't; that rate still hits the relatively obscure profit on collectibles and special small-business stock. So you still have to weave through the 36 lines on the back of Schedule D. Be patient: It's just a lot of addition and subtraction.

WORKSHEET MANIA. If you're taking advantage of any of the new tax breaks that show up on this year's forms--the child credit, education credit or Roth IRA--there's a paperwork price to be paid.

The new child credit--worth $400 for each child under age 17 you claim as a dependent--is relatively straight-forward, but it takes an 11-line worksheet to claim it. And if you have three or more qualifying children, you're directed to another ten-liner.

Negotiating the worksheets can be confusing, but it serves a purpose: to make sure you're entitled to claim the credit. The right to the child credit, for example, is phased out as adjusted gross income (AGI) rises above $110,000 on a joint return or $75,000 on a single or head-of-household return.

You'll see a reference to an "additional child tax credit" in the instructions, but don't scramble to find the Form 8812 you need to claim it. It's only for taxpayers who have three or more children and whose income is so low that the child credits more than wipe out their entire tax liability.

If a Hope or Lifetime Learning credit will reimburse you for part of the college tuition you paid in 1998, you'll need Form 8863, on which you calculate whether you meet the credits' income limits. The Hope credit is worth up to $1,500 for each freshman and sophomore student for whom you paid tuition and fees; the Lifetime Learning credit is worth up to $1,000 (per return, not per student) for college bills beyond the first two years. These credits disappear as AGI rises between $40,000 and $50,000 on a single or head-of-household return and between $80,000 and $100,000 on a joint return.

You'll be directed to a worksheet in the 1040 instructions if you want to write off student-loan interest. You guessed it: This paperwork, too, is designed to make sure you're not too rich to get a break. The deduction--which you can claim whether or not you itemize--evaporates as income rises between $40,000 and $55,000 on a single or head-of-household return and between $60,000 and $75,000 on a joint return.

REPORTING ROTH MANEUVERING. Did you convert a traditional IRA to a Roth last year? Did you unconvert--and then maybe reconvert? If so, you'll be spending some quality time with Form 8606. Remember, a conversion to a Roth is treated as a payout from your old IRA, and a "recharacterization" (the official name for an unconversion) is considered a payout from the Roth. The IRS wants all the details.